Monday, May 05, 2008

Countrywide Is On A Slide

Not surprisingly, given the results I posted about last week, the BAC deal to buy Countrywide is being questioned. CR, Bloomberg, Reuters. Look at those results. BAC would be getting a money pit.

I wonder if the Feds are going to have to cough up to get CW tucked away safely somewhere. Before someone starts screaming bailout, remember that Countrywide is into the FHLB system for quite some chunk of cash. Schumer was right to raise the question last year. So it is likely just a question of payees - of whether the Feds fund a CW takeover or whether they have to ante up to protect the FHLB system, not whether the Feds have to ante up.

As home prices decline, the ability to buy homes increases. So the path to least losses is to allow the market to work. The viable outfits will be able to lend to the new buyers as long as they can get the money to fund those mortgages. Sustaining that flow of money is the purpose of the FHLB system.

But CW looks to be as dead as they get while still walking and it is just not thinkable that they will continue to walk alone.

While other banks have also increasingly relied on the FHLB system, none have done so with more haste than Countrywide. Through the first three quarters of this year, Countrywide’s advances from the Atlanta-based FHLB bank had soared 81 percent, to a total of $51 billion. That represents nearly 40 percent of FHLB Atlanta’s total advances, according to the bank’s latest SEC filing—a potentially dangerous level of exposure considering Countrywide’s track record in poor underwriting and predatory lending practices in recent years.

CW originally handed over a significant overcollateralization in its loans, but as my post last week pointed out, the value of those loans is dropping rapidly.

The FHLB system will have to be sustained, because it is critical to the ability of lenders to continue to grant mortgages.

As to why BAC ever wanted into this deal, the reason is that they have run up against the 10% limit on domestic deposits. CW has been frantically opening bank branches. Once BAC merges with CW, it can exceed the limit if internal growth is generated. I left a link to this article reviewing BAC's growth problem in 2003 over at CR. At that point BAC was merging with FleetBoston, and this is the relevant portion:

H. Rodgin Cohen, chairman of the New York law firm of Sullivan & Cromwell and a specialist in banking law and mergers, said that once the deal closes and the combined bank starts operating as a single entity, it's acceptable under the law to exceed 10% of total deposits, so long as it happens "organically" from internal growth as opposed to another merger.

Honestly, that's why BAC got into this in the first place. I'm sure of it. BAC has no other way to expand easily in the US, and it is very costly to move into new markets by building new branches.

Before someone starts screaming bailout, remember that Countrywide is into the FHLB system for quite some chunk of cash. Schumer was right to raise the question last year. So it is likely just a question of payees - of whether the Feds fund a CW takeover or whether they have to ante up to protect the FHLB system, not whether the Feds have to ante up.

This is wrong. The only thing federal about FHLB is the name (and silly assumptions people make when buying their bonds). The FHLB is not part of the governement and imposes no liabilities thereon. I say let CFC go sdown, and let FDIC clean up the individual banks that own the FHLB. It is time to, once and for al, drive a stake through the heart of "too big to fail". We will self-destruct otherwise.

From Wikipedia:

"The mission of the FHLBanks reflects a public purpose (increase access to housing and aid communities by extending credit to member financial institutions), but all 12 are privately capitalized and, apart from the tax privileges, do not receive taxpayer assistance."

Yeah, but Bob, it's the federal government which will have to ante up money for the FHLB system if CW defaults. The banks don't have enough money to buy a lot more stock right now.

And if the FHLB money dries up, so does the funding streams for new mortgages. Vehicles like the FHLB was originally put in place to provide liquidity during downturns to prevent the noxious downward spiral that produced the Great Depression.

IT STILL WORKS THAT WAY.

If banks tried to put more money into the FHLB system, they'd be withdrawing it directly from loans to consumers and small businesses. It is the small business loans that would have the worst effect on the economy.

The system is at capacity. If you let the banks fail, we will very shortly find ourselves bailing out the FDIC fund. One way or another, more capital will be injected into the system. The object is to keep that capital minimal and eventually produce a return to the taxpayer.

This situation could easily end in a Great Depression if lending to viable borrowers is not maintained. Very easily.

Btw, small business funding has traditionally relied quite a bit on home equity loans. Need I say more?

The FHL banks serve a lot of functions. For example, they shared in the payment for the Ref Corp debt which arose from the 80's thrift crisis. They are not a truly private set of institutions, but a public-private hodgepodge which also funds all those Congressionally mandated housing programs, for example.

Yeah, but Bob, it's the federal government which will have to ante up money for the FHLB system if CW defaults.

Last I looked, the Federal Governement is already borrowing. So if they plow money into CFC (or FHLB or FDIC), they must either raise taxes, sucking money out of the economy, or borrow, sucking money out of the economy. It's a zero-sum game, except my way, we finally end the "too big to fail" paradigm which is obviously infesting a lot of decision making.

If you want to let the market work, then let it work.

I don't want to see a Deprssion anymore than anybody else, but there *is* going to be pain any way we go - the question is do we come out the other side better, or is it the same old corporate-welfare, crony-capitalism we've been getting screwed with for the last 30 years?

Bobn - Okay, the repeal of Glass-Steagall in the 90s has left us in a situation so bad that the market can't work efficiently. That's the truth.

A much-expanded scope of regulation is going to be needed to deal with the effects of repealing Glass-Steagall. Until then, we just have to punt.

Some types of Fed supports are not zero-sum. For instance, if money is extracted from the community bank system, it sets up a rolling set of demands on businesses to repay their loans. This would constrain the economy far more than the effect of a Ref Corp type bailout.

The trick is to keep the infusion of money as low as possible, to make it repayable, and to make it competitive so as to allow the market to weed out the worst players. Over time, this supports economic growth.

So, for example, whatever the regulators and the federal government does to deal with the CFC situation should be structured to stick the CFC investors with most of the losses. You have to make sure that there is a big penalty for being a losing player.

Btw, I utterly agree with the "crony capitalism" comment. This is true, and it is those interests which have governed policies like the repeal of Glass-Steagall and that have produced the current mess.

It's both parties, so there is no easy out. I think Americans are going to have to beat on their Congress Critters and demand a new deal.

Right through last year, most of the political proposals were the same type of thing.